The Heritage Foundation

Executive Summary #1214es on Asia

August 17, 1998

August 17, 1998 | Executive Summary on Asia

BG1214es:  Indonesia's Economic and Political Crisis:  AChallenge for U.S. Leadership in Asia

Indonesia is calm now after riots in May that claimed over 1,000 lives and hastened the end of President Suharto's 32-year reign. The rioting began as peaceful demonstrations against the Indonesian government's handling of the severe economic effects of the Asian economic crisis. Despite the conclusion of four economic stabilization agreements between the International Monetary Fund and the Indonesian government, economic privation persists. Unemployment is likely to be running at more than 40 percent. Inflation could reach 100 percent this year. Indonesia's currency has lost so much of its value that many Indonesians no longer can afford food and basic necessities. The economy has ground to a halt because Indonesians cannot afford the raw materials to produce, and international investors have pulled out and have yet to return. Thus, it is not surprising that half the population has slipped below the poverty line and that, by year's end, Indonesia's economy will have shrunk by 15 to 30 percent. To make matters worse, predictions of severe food shortages later this year have raised fears of renewed social unrest.

There are still reasons for hope, however. Indonesia possesses great natural resources, including oil, natural gas, timber, minerals, and rich farmland. It has an impressive transport infrastructure, a large consumer market, and a young and well-educated work force that is very attractive to manufacturers. Moreover, under new President B. J. Habibie, Indonesia has made progress toward the political reforms necessary to restore investor confidence, spark renewed growth, and lead to a democratic political system. Habibie has called for new parliamentary elections in mid-1999, allowed the formation of political parties, relaxed press restrictions, released political prisoners, and started to resolve the issues of East Timor and the role of the military in Indonesian society.

But much remains to be done. Before prosperity and stability can return, Indonesia must overcome its long legacy of corruption and "crony capitalism." This corruption and favoritism must cease so that Indonesia's economy can operate on a level playing field guided by the rule of law. This will rebuild international confidence and attract investors. A good first step would be reform of Indonesia's legal system to create an independent judiciary and make clear that the law applies to everyone. Indonesia also could create a better business environment by reducing its barriers to trade, which Suharto used to benefit the business interests of his family and friends. Agricultural reform is necessary: Production subsidies must be reduced and price controls eliminated to enhance farm productivity and create incentives for production. Finally, Indonesia must attempt to regain the trust of its ethnic Chinese minority, which controls more than 70 percent of Indonesia's wealth and comprises an important part of the distribution system. Indonesia has a history of mistreating its Chinese population, and many Chinese fled the country when targeted by violence during the May riots. Habibie must allay the fears of the Chinese: If they are willing to reinvest in Indonesia, international financiers are likely to follow suit.

The United States has a great interest in a prosperous and stable Indonesia that continues to evolve toward democracy. By assisting Indonesia to recover economically, the United States could foster a broader economic recovery in Asia as well. This would be vital to U.S. interests because, by some estimates, Asia's financial crisis could slash $120 billion from U.S. gross domestic product by next year. Indonesia is important to the United States in terms of Asian security, too. It sits astride vital sea lanes through which 40 percent of the world's shipping passes, including 80 percent of Japan's oil supply and 70 percent of South Korea's. And Indonesia, the world's largest Muslim state, has acted as a moderate force in the Islamic world.

To facilitate reforms to revive Indonesia's economy and encourage its transition to a democratic political system, the United States should:

  • Invite Indonesia's President to Washington after sufficient progress has been made toward reform.

  • Accelerate delivery of food aid to forestall the possibility that widespread shortages will lead to renewed rioting, setting Indonesia back further and wiping out the gains already made.

  • Urge Indonesia to increase economic and legal transparency to establish confidence in the rule of law.

  • Urge Indonesia to open its banking system to fuller disclosure and to strengthen supervision so that future crises can be averted. The United States could share the hard-won lessons of its savings and loan crisis of the late 1980s both in liquidating insolvent banks and effectively regulating those that survive.

  • Urge Indonesia to remove barriers to trade and investment so that investors might return and the economy can start moving again.

  • Offer Indonesia the benefit of U.S. experience in building democracy as it engages in political party-building activities in preparation for next year's elections.

  • Promote reforms within Indonesia's military and rebuild U.S.-Indonesia military ties. Restoration of the International Military Education and Training program would encourage respect for human rights and an evolution toward civilian control in Indonesia.

Just as Indonesia's economic crisis has caused tremendous suffering, it also offers the opportunity to adopt a far better economic and political order. By offering its assistance, the United States can help Indonesians emerge from their crisis and perhaps build the world's third-largest democracy. An economically reformed and democratic Indonesia would make a worthy strategic partner for the United States in Asia.

-- John T. Dori is a former Research Associate in The Asian Studies Center at The Heritage Foundation.

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